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Determining the Impact of Recent Growth in Unregulated DETERMINING THE IMPACT OF RECENT GROWTH IN UNREGULATED FINANCE ON CHINA’S REAL ESTATE MARKET Matthew Laitkep TC 660H Plan II Honors Program The University of Texas at Austin May 11, 2017 __________________________________________ Dr. Laura Starks McCombs School of Business Supervising Professor __________________________________________ Dr. Valerie Bencivenga Department of Economics Second Reader ABSTRACT Author: Matthew Laitkep Title: Determining the Impact of Recent Growth in Unregulated Finance on China’s Real Estate Market Supervising Professors: Dr. Laura Starks, Dr. Valerie Bencivenga The purpose of this thesis is to analyze how recent growth in China’s unregulated finance system has affected the growth and stability of China’s real estate market. The thesis takes a comprehensive approach to analyze two of the main drivers of growth in unregulated finance, investors and local governments, and their relationship to the real estate market. Wealth management products (WMPs) are sources of unregulated finance for domestic Chinese investors that have grown exponentially in the past decade. WMPs provide high rates of return to investors by investing in real estate, small businesses, and other relatively high risk projects. Like investors, local governments also have had a need for new investments. Local government debt as a percentage of GDP has continued to increase, and local governments have utilized urban developments and land sales to fund their budget deficits. Local governments have increased their use of local government financing platforms (LGFPs), state-owned enterprises that issue loans and raise funds on behalf of local governments, to get around loan restrictions placed on them by the central government. Thus, large-scale urban projects have continued to be produced at a high rate. Ghost cities are large urban districts built by local governments that sit almost entirely vacant. Case studies on two ghost cities, Kangbashi New Area and Zhengdong New District, exhibit some of the factors affecting local governments and how they relate to the real estate market. Going forward, potential unregulated finance issues include the rise of unregulated mobile finance for investors and high debt levels for local governments. Acknowledgements I would like to thank my thesis supervisor, Dr. Laura Starks, and my second reader, Dr. Valerie Bencivenga, for their help and support during the thesis process. They helped me shape my thesis question, provided ideas for research, and guided me as I articulated my ideas. I also would like to thank my family and friends for their constant prayers and support. I could not have completed the thesis without them. Table of Contents Chapter 1: Introduction and Overview ........................................................................................... 1 Chapter 2: Real Estate Privatization and Growth of Unregulated Finance .................................. 10 Chapter 3: Wealth Management Products .................................................................................... 22 Chapter 4: China’s Local Governments and Debt ........................................................................ 33 Chapter 5: Ghost Cities ................................................................................................................. 45 Chapter 6: Moving Forward – The Future of Shadow Banking in China .................................... 59 Chapter 1 References .................................................................................................................... 63 Chapter 2 References .................................................................................................................... 64 Chapter 3 References .................................................................................................................... 66 Chapters 4 and 5 References ......................................................................................................... 68 Chapter 6 References .................................................................................................................... 71 Biography ...................................................................................................................................... 72 Chapter 1: Introduction and Overview Introduction Since 1978, China has experienced a massive economic boom that has helped the country reach new heights. China’s real estate industry has seen the building of numerous magnificent skyscrapers in cities like Shanghai and Guangzhou, the creation of entire urban districts in small cities, and brand-new apartments in Beijing to house newcomers and locals alike, all within the past three decades. Entire cities have changed completely in the midst of modernization and urbanization. Chinese urbanization is unprecedented in recent history, with huge numbers of people moving from the countryside into cities. The percentage of people living in cities was only 18% in 1978. Presently, about half of the population lives in urban areas, and the government has set a goal of 75% living in urban areas by 2025 (Johnson, 2013). One example of Chinese urbanization is Shanghai, a large city located in eastern China. From 1990 to 2013 (Figure 1), Shanghai built a new financial district along the Huangpu River. This area of the city, which just 20 years ago was an empty piece of land, is now the main economic center of Shanghai, with skyscrapers rivaling those seen in Lower Manhattan in New York City. What makes the story of China’s rise even more impressive is that this story of rapid development in Shanghai is a story that has occurred in cities across China. The rapid development and urbanization of China serve as a visualization of China’s impressive and rapid rise to economic power, and expectations are high that China’s economy will soon rival the United States’ economy. A central question is whether China is capable of maintaining its current breakneck pace of growth, or if certain factors, such as increasing debt levels and growing risks from shadow banking, will slow the pace of urban development. 1 Figure 1. Building Boom: Shanghai in 1990 (Top), and Shanghai in 2013 (Bottom) Source: Diaz, J. (2010). “Shanghai skyline: Before and after.” Gizmodo. While China’s growth has been exceptional, the financing of large real estate projects has resulted in increasing debt at the local government level. Investors, eager to find investments with high yield, have flocked to real estate developments, resulting in large increases in property prices. Funding for these projects has become much more complex, as local governments and investors alike have created new methods of unregulated finance to continue rapid economic growth. The equity market in China continues to develop slowly, but it is not capable of handling the surge of investors searching for high yield investments. Investors thus have been seeking an asset class that will provide the returns that they need, and one area of particular interest to investors is real estate. The real estate market has seen consistent long-term growth for several 2 decades. With high growth nearly certain, investors can buy property, even at high prices, and expect to sell it at a higher price. After real estate privatization during the 1980s and 1990s, real estate investment has seen double-digit growth (Figure 2). High growth in real estate investments has been consistent even if growth over short-term periods has been volatile at times. This consistency has been vital for local governments that have funded their budgets with land sales and urban development. It has also been important for investors, who have speculated on the value of real estate on the assumption that its value would continue to increase. Figure 2. China Real Estate Investment Growth, 1998-2013 Source: Nie, J., and Cao, G. (2014). China’s slowing housing market and GDP growth. In order to keep up with investor demand and fund their budgets, local governments have continued to produce urban development projects at a high rate. Local governments have had 3 control over land development since reforms were enacted by the Chinese central government that passed control to localities. They have taken advantage of land control by building developments on the land and by selling it for a profit (Sheng & Soon, 2016). These developments help local governments fund their budgets while also providing opportunities for investors who believe that they also can profit from these ventures. As local government debt continues to rise, reliance on profit-making from real estate developments is further entwining local governments and investors. The central government has become concerned that growth is too high and has attempted to take steps against it. However, attempts to slow local governments and investors have not succeeded, as funding within the shadow banking sector has increased even as traditional forms of financing have not seen the same increases. Increased reliance on shadow banking has augmented financial complexity, and it is making it harder for the government to track high-risk investments. Local governments are setting up state-owned enterprises to act on their behalf, and banks are creating financial products in trusts so that they remain off their balance sheet. Careful analysis is necessary in order to understand these recent trends and the relationship between local governments and investors. Methods of Analysis One of the goals of this thesis is to determine what conclusions
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